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REVISITING HOLDING COMPANY LIABILITYFOR SUBSIDIARY COMPANY DEBTS IN

AUSTRALIA:A RESPONSE TO THE JAMES HARDIE

CONTROVERSY

James McConvill*

I ABSTRACT

In September 2004, a major report into Australia’s largest productsmanufacturer James Hardie’s controversial corporate restructuringwas handed down by Commissioner David Jackson QC. In the reportthe Commissioner gave a detailed account of the events leading up toJames Hardie’s restructuring and movement of corporateheadquarters to The Netherlands, and the potential impact this has onvictims of asbestos-related diseases caused by James Hardie’s oncesubsidiary companies. One of the implications of the corporaterestructuring was that the new holding company in the James Hardiecorporate group was shielded from any litigation taken out against thesubsidiary companies by asbestos victims due to the establishment of afund, the Medical Research and Compensation Foundation. This wascompletely separated from the James Hardie Group. In the report, theCommissioner did not engage in much consideration as to howcorporate law in Australia could be reformed to make a holdingcompany liable for the debts of its subsidiary companies resulting fromdeath or personal injury, yet potential law reform has certainly drawnthe attention of a number of commentators both before and after thereport was handed down.

What the majority of commentators, including Counsel Assisting theJames Hardie Inquiry, have suggested is that limited liability (acornerstone principle of corporate law) should be restricted so that aholding company (often the only shareholder of a subsidiarycompany) will be held liable for subsidiary company liabilitiesresulting from personal injury or death. According to the author, thebroad call for reform to ‘restrict the limited liability principle’ inresponse to the report into James Hardie’s restructuring is misguidedand troubling. Limited liability is an important privilege bestowed onshareholders, both large and small, and should only be restricted whenthere is an overriding justification for doing so. While an obvious effectof subjecting holding companies to liability for debts of its subsidiariesis to restrict the application of limited liability to holding companies(as the largest shareholder in the subsidiary), law reform can achieve

* Lecturer-in-Law, Deakin University.

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1 See, eg, Ian Ramsay, ‘Allocating Liability in Corporate Groups: An AustralianPerspective’ (1999) 13 Connecticut Journal of International Law 329; and to a lesserextent Steven R Ratner, ‘Corporations and Human Rights: A Theory of LegalResponsibility’ (2001) 111 Yale Law Journal 443.; David B Noakes, ‘Reform to theLaw of Corporate Groups in Australia to Protect Employees’ (2000) 34 The Universityof British Columbia Law Review 239.

this effect without undermining the general operation of limitedliability. In this article, the author suggests that the response to theJames Hardie controversy should be more measured, focusing on thespecific problems which occurred with James Hardie, and (keeping thisin mind) in constructing a law reform proposal designed to achieve thecommonly accepted objective in the aftermath of the James Hardiecontroversy. This is, implementing corporate law reform so thatholding companies can be liable for tortious claims resulting fromnegligent acts or omissions of subsidiary companies when thesubsidiary is unable to pay.

II INTRODUCTION

A Overview

Australia’s approach to the regulation of corporate groups has been ofinterest to scholars and practitioners of corporation law worldwide,including in the United States.1 The regulation of corporate groups, andin particular the issue of holding company liability for subsidiarycompany debts, resurfaced as one of the most reported topics inAustralian newspapers and journals during 2004 as a result ofcontroversial corporate restructure carried out by James Hardie Ltd, alarge products manufacturer, in 2001.

James Hardie established a new parent company in The Netherlands,ostensibly to take advantage of favourable tax laws. However as part ofthis restructuring it merged two of its subsidiary companies into a newentity, the Medical Research and Compensation Foundation (‘MRCF’),with a view to providing compensation to asbestos victims, andcompletely separating compensation claims from the James Hardiegroup. Approximately $A300 million was allocated to the fund toprovide compensation to victims of asbestos-related diseases, howeverit soon became apparent that the asbestos claims would well and trulyexceed the $300 million allocated. By early 2004, it was clear that acrisis had emerged – it was by then estimated that the total amount ofcompensation to be paid to asbestos victims could in fact draw close to$A2 billion. Accordingly, by setting up a new entity which wascompletely separated from the James Hardie group to be responsible forasbestos claims resulting from the negligence of its subsidiaries, withsuch a large shortfall, the James Hardie group would avoid liability,leaving asbestos victims short-changed, unless something was done

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about it.

In early 2004 due to the emerging crisis facing the MRCF and asbestosvictims, the New South Wales Government in Australia set up a SpecialCommission of Inquiry, chaired by David Jackson QC, to put on therecord; how the crisis developed, who was responsible, what wentwrong and why. The Commission was established with a view todetermine whether imposing liability on the ultimate holding companyof James Hardie was an appropriate and reasonable course of action totake. Millions of dollars were spent examining the factual matrixinvolved in James Hardie’s restructuring over a number of months in2004, with a final report handed down by Commissioner David Jacksonin September 2004.

Importantly, over 90 per cent of the report gave a detailed account ofevents leading up, and subsequent to, the establishment of the MRCFand move of corporate headquarters to The Netherlands. In his report,David Jackson QC briefly touched upon possible options/situations inwhich whereby the holding company could be made liable for theextensive shortfall in compensation, but did not go further and actuallypropose any models, leaving this to be subsequently debated bygovernments and commentators. Both prior, and in response, to theCommissioner’s report in September 2004, a number of possible optionsfor reform were raised. This included the possible establishment of astatutory fund to compensate asbestos victims, and also reform toprinciples of negligence to make it clear that in some circumstancesholding companies and/or their directors can be held liable for thenegligent acts or omissions of subsidiary companies.

The main call for reform, which emerged in response to the problemsassociated with James Hardie’s corporate restructuring, was to restrictthe application of the limited liability principle to holding companies.The general consensus, amongst commentators pushing for suchreform, was that where personal injury or death is caused by a subsidiarycompany whilst part of a corporate group, there should be a ‘lifting’ ofthe corporate veil so that liability can be sheeted home to the holdingcompany. This was considered to be a particularly useful reform,considering such circumstances like that of James Hardie and the MRCF.Where the entity responsible for the negligence claim no longer has thefunds to meet the claim, the victim in a particular case will lose out.Unless the veil of the company can be lifted to attach liability to theentity which was the major shareholder at the time when the negligentact or omission occurred, the holding company.

The wide-ranging calls for ‘restricting limited liability’ were the impetusfor my decision to comment on the James Hardie controversy by way ofthis article. In my view, the principle of limited liability, an important

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privilege bestowed upon shareholders, should only be restricted if thereis a clear justification for doing so based upon public policy. It is arguedin this article that focusing directly on limited liability in the case ofJames Hardie, and similar scenarios, is unnecessary and undesirable.The same objective can be achieved without directly attacking limitedliability.

B Purpose of this Article

In this article, I will construct and explain a corporate law reforminitiative which specifically responds to the James Hardie corporaterestructuring, and is designed to meet the present objective in corporatelaw in Australia of enabling liability to be directed to holding companiesfor claims imposed when a entity was a subsidiary company at the timethat the negligent act or omission occurred. Importantly, my proposalhas also been designed to attach liability to a holding company (or what Iwill later refer to as the ‘controlling entity’) for claims against a subsidiarycompany (what I will later refer to as the ‘controlled entity’) even if, asoccurred with James Hardie, subsequent to the negligent act or omissionthat company has been completely separated from the corporate groupand is thus not a subsidiary company when the debt is ‘incurred’.

I outline a case for amending s 588V-W of the Corporations Act 2001(Cth) (‘Corporations Act’), so that a subsidiary company, or a companywhich has assumed the liabilities of a subsidiary company, is deemed toincur a debt if it becomes liable for tortious damages or a criminal fine.The effect of this small, but significant, amendment is that in particularcircumstances what is essentially the holding company could becomeliable if the subsidiary company is under funded and cannot afford topay the debt when the debt is incurred (which will be defined to be thepoint in time in which the amount is liquidated). As already mentioned,my reform proposal also involves a technical amendment to s 588V tochange who is potentially liable from a ‘holding company’ to a‘controlling entity’. The change is subtle but again important, forreasons, which will be explored later.

As will be explained in the article, the key benefit of my proposal toamend s 588V of the Corporations Act is that it provides an avenue forliability to be imposed on holding companies in a corporate group,including James Hardie in relation to the impending shortfall of funds inMRCF (notwithstanding, as discussed below, that James Hardie reachedan agreement to compensate asbestos victims in the short term),without directly undermining the principle of limited liability. Afundamentally important aspect of my proposal is that liability will notbe imposed on companies simply as a result of being substantialshareholders in a subsidiary company within a group. Instead liabilitywill be imposed on the basis that the company exerted control over the

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controlled entity at the time when the negligent act occurred, and onthat basis the controlling entity should accept some responsibility if thecontrolled entity is not in a position to meet tortious claims.2 Again, thisdifference in approach will be explored in the article.

What is also important to make clear at this point is that in constructinga corporate law reform proposal to impose liability on a holdingcompany in particular circumstances, but in a way which does notdirectly undermine the operation of the limited liability principle, thereare some difficulties which confront the proposal. This is particularlythe case where a controlled entity is responsible for a ‘latent’ asbestos-related disease which is discovered, and a claim made in relation to it,after the controlled entity has been wound up. The special nature ofasbestos-related diseases, and how the special nature of such diseasesmay limit the operation of my proposal, will also be explored.

C What this Article Does Not Do

The purpose of this article is to outline and justify one possible reforminitiative which responds to the recent call in Australia for the law tofacilitate liability being imposed on holding companies for the debts ofits subsidiaries arising from personal injury or death. I expect that theanalysis and reform initiative provided in this article will also be ofinterest to readers in other jurisdictions confronting the issue of how toeffectively impose liability in complex corporate group arrangements.

The proposal for reform which will be outlined in this article has beendesigned to deal with the particular issues and difficulties arising fromJames Hardie’s corporate restructuring, and for similar scenarios whichoccur in the future. This is done, however, in a manner which does notdirectly undermine the application of the limited liability principle,given the importance of limited liability as a privilege belonging toshareholders (a point which will be expanded upon). Given thedifficulties for asbestos victims resulting from James Hardie’srestructuring, the scope of this article could have been far more wide-ranging. Exploring the desirability of the operation of limited liabilityand separate entity doctrine in the context of corporate groups, therationale for corporate groups, and the potential for reform in areas


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2 This basis for imposing liability on the holding company (or ‘controlling entity’), thatis where the holding company clearly shares some responsibility for the subsidiarycompany’s misfortune, rules out other commonly raised reform proposals, such asbeing able to impose US-style contribution or pooling orders.

3 See in particular the report of the Companies and Securities Advisory Committee,Corporate Groups Final Report (2000), which the reader is referred to gain a betterunderstanding on the nature of corporate groups, the issues in relation to limitedliability and separate entity doctrine applied in a group context, and the different


outside corporate law. However, I believe that these issues have beendealt with in sufficient detail in other forums,3 and I leave it to othercommentators to explore other possibilities for reform in response tothe James Hardie controversy.

D Structure of Article

The structure of this article is as follows. Part III provides a backgroundreport on the James Hardie controversy, looking at; the James Hardierestructuring and the impact this has had on present and future asbestosclaimants, the Special Commission of Inquiry examining the JamesHardie controversy, and the findings of Commissioner Jackson. Part IVfocuses on the calls for corporate law reform both during and after theSpecial Commission’s proceedings, and more specifically the calls torestrict the principle of limited liability in the context of corporategroups. I provide a critical analysis of this suggested approach to lawreform. In Part V, I set out in detail and then justify a proposal for lawreform, involving changes to s 588V-X of the Corporations Act. I alsorespond to inevitable arguments that could be made against theproposal. It is explained that the key strength of the proposal is that itis a moderate and balanced response to the problems which arose withJames Hardie and which could reoccur in the future. Most importantlyit would fulfil the objectives underlying the recent calls for reform, butwithout directly undermining the principle of limited liability.

III BACKGROUND REPORT ON THE JAMES HARDIECONTROVERSY

A The James Hardie Restructuring

The significance of asbestos in Australian society, and the dominance ofJames Hardie as a products manufacturer, certainly gave the problemsinvolving James Hardie and the embattled MRCF particular prominencein Australia. As Commissioner Jackson noted in his report:

Asbestos was used in Australia during a large part of the last century in themanufacture of building products (particularly sheeting and roofing),pipes, insulation materials, brake linings and other friction products, and

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possibilities for reform so that creditors of subsidiary companies can potentially turnto the holding company for payment. The report also includes a rich source ofacademic references on these issues. The CASAC report is available on-line at http://www.camac.gov.au/camac/camac.nsf/byHeadline/PDFFinal+Reports+2000/ $file/Corporate_Groups,_May_2000.pdf.

4 See D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004) [2.1]. The report is available on-line


other materials. Asbestos, however, carries with it problems. Its fibres cangive rise to asbestosis, lung cancer, asbestos-related pleural diseases andmesothelioma.4

A research note prepared by the Australian Parliamentary Library in2004 provides a useful summary of the events involving James Hardie’srestructuring and the impact this had on asbestos claims:

Between 1937 and 1986 asbestos products were manufactured by twosubsidiaries of James Hardie Industries Ltd (JHIL): now known as Amaca(building and construction products) and Amaba (brake linings). Between1996 and 2001 the assets of Amaca and Amaba were transferred to JHIL(now ‘ABN 60’) then to a Netherlands-based company- James HardieIndustries NV (JHI NV). In February 2001 ownership of Amaca and Amabawere transferred to a new body, the [MRCF], which was given $293million to fund asbestos injury claims.

In October 2001 the Hardie Group assured the NSW Supreme Court thatABN 60 could call on $1.9 billion owed by JHI NV for partly paid sharesto meet future asbestos claims … But in March 2000 ABN cancelled thepartly paid shares without informing the court or the stock exchange.5

This separation, and the movement of Group funds away from the entitywhich assumed the asbestos liabilities, was the cause of the presentproblems.

According to Commissioner Jackson’s report, the primary reason givenby James Hardie for this separation was to support Hardie’s expansionin the more lucrative US market. ‘The principal purpose of separationwas to enable the Group thereafter to obtain capital or loan funding orto use its own share capital for future acquisitions without the stigma ofpossible future asbestos liabilities.’6

Based on chapter three of the Commissioner’s Report (‘TheFoundation’s Present Financial Position’), at the time when the MRCFwas set up in 2001, the assets transferred to the MRCF, from varioussources, amounted to A$293.5 million. A question was whether theMRCF’s financial position was likely to be sufficient to meet its futureasbestos-related liabilities in the medium-to-long term. At 30 June 2004,net assets of the companies were A$179.2 million, with this amountsince decreasing rapidly due to new asbestos related claims (approxi-mately A$63 million). According to the Commissioner’s report, theMRCF’s funds were quickly being used to meet current claims, and it


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at: <http://www.cabinet.nsw.gov.au/hardie/PartA.pdf >5 See Peter Price, Jerome Davidson and Susan Dudley, ‘In the Shadow of the Corporate

Veil: James Hardie and Asbestos Compensation’, Australian Parliamentary LibraryResearch Note No. 12, (2004-2005). Available on-line at:http://www.aph.gov.au/library/pubs/rn/2004-05/05rn12.htm.

6 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004), [1.6].

7 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the Medical


was expected that the funds would be exhausted by the end of 2006 orearly 2007, ‘with no prospect of meeting the liabilities of Amaca andAmaba in either the medium or the long term.’7

What needs to be emphasised very clearly, based on the above facts, isthe MRCF’s complete separation from the James Hardie Group. It couldbe presumed from media coverage talking of potential liability for‘holding companies,’ that the MRCF is a subsidiary within the JamesHardie Group, or at least was at the time when the Special Commissionof Inquiry was being conducted, and hence the veil should be piercedto impose liability on the holding company.

That is an incorrect account of James Hardie’s restructuring and theposition of the MRCF. The MRCF has been completely separated fromthe James Hardie Group since 2001, and hence if limited liability wereto be restricted in relation to the debts accrued by MRCF, it would notbe the parent company in the James Hardie Group that would besubjected to liability.

Why the issue of subjecting holding companies to the liabilities of itssubsidiaries has come up in the context of James Hardie is not becausethe MRCF is a subsidiary of James Hardie’s holding company now, eventhough the James Hardie Group were responsible for setting up theMRCF and hence could be said to have exerted some ‘control’ of theMRCF within the meaning of the Corporations Act. Rather it is becausethe subsidiaries of James Hardie Industries, which were responsible forthe manufacturing and use of asbestos-related products (Amaca andAmaba), were joined to become the MRCF. Hence, more precisely whatis sought to be done is to impose liability on the holding company forclaims resulting from negligent behaviour by companies which weresubsidiaries at the time when the negligent act or omission occurred. Itis important to understand this difference as it helps to clarify the extentof the difficulties involved in imposing liability on the James HardieGroup. This is due to the shortfall of funds in the MRCF, and doesimpact on the way in which reform of the Corporations Act should beapproached.

As will be discussed later, in October 2004, the New South WalesGovernment were seriously considering introducing general legislationwhich would have had the effect of unwinding the separation ofasbestos-related liabilities from the James Hardie Group. There arespecific problems with this approach to reform (which I will discuss laterin this article), confirming that the statutory scheme approach is inferiorcompared to the author’s proposed reforms to s 588V-W of the Act.

B Establishment of a Special Commission of Inquiry

In response to concerns about the impending shortfall in MRCF’s

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resources to compensate asbestos victims, and the impact that thiswould have on victims of asbestos-related illnesses, on 27 February2004, following instructions of the NSW Premier, Bob Carr, theGovernor of NSW signed letters patent establishing a SpecialCommission of Inquiry. David Jackson QC was appointed asCommissioner and instructed, by terms of reference, to report on thefollowing matters:

1 The current financial position of the MRCF, and whether it is likelyto meet its future asbestos related liabilities in the medium to longterm;

2 The circumstances in which MRCF was separated from the JamesHardie Group and whether this may have resulted in or contributedto a possible insufficiency of assets to meet its future asbestos relatedliability;

3 The circumstances in which any corporate reconstruction or assettransfers occurred within or in relation to the James Hardie Groupprior to the separation of MRCF from the James Hardie Group to theextent that this may have affected the ability of MRCF to meet itscurrent and future asbestos related liabilities;

4 The adequacy of current arrangements available to MRCF under theCorporations Act to assist MRCF to manage its liabilities, andwhether reform is desirable to those arrangements to assist MRCF tomanage its obligations to current and future claimants.

The first two of the terms of reference are especially relevant for thepurposes of this article, and in constructing a law reform proposalwhich responds to the special issues in James Hardie, as well aseffectively dealing with future situations. The date for delivery of theinterim report was originally set for 30 June 2004, but was laterextended to 21 September 2004.

C Commissioner Jackson’s Findings

Commissioner Jackson’s highly publicised report, titled ‘Report of theSpecial Commission of Inquiry into the Medical Research andCompensation Foundation’ was handed down on 21 September 2004.

The first and most important (in particular for the purposes of thisarticle) term of reference of the Jackson Inquiry, which was dealt within the report, related to ‘the circumstances in which MRCF wasseparated from the James Hardie Group and whether this may haveresulted in or contributed to a possible insufficiency of assets to meet itsfuture asbestos-related liabilities.’

Commissioner Jackson explained in the report that the restructuring of


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the James Hardie Group and the separation of the asbestos-liablesubsidiary companies from the Group was not illegal, and indeed was avalid arrangement by the company with a view to elevating its shareprice and attracting US capital. Commissioner Jackson did find,however, that the separation from the Group was a cause of the MRCF’spresent dilemma, and that on the facts the Group did bear someresponsibility for this. According to Jackson, ‘I find it difficult to acceptthat management could really have believed that the fund of theFoundation would have been sufficient to enable it to pay all futurelegitimate asbestos-related claims against Amaca and Amaba.’8

Commissioner Jackson then stated later in the report:

… there was no legal obligation on JHIL to provide Amaca and Amaba, onseparation, with any funds in addition to the assets of those companies.Amaca and Amaba were not stripped of assets; they retained them.Indeed they obtained more than those assets by reason of the additionalperiodic payments. … But in practical terms, separation was, in myopinion, likely to have an effect of that kind. If separation had not takenplace in February 2001, it seems likely that, for the indefinite future, theasbestos liabilities would have been treated, as they had been for years, asone of the annual expenses of the Group.9

D Historic Agreement

Despite the fact that it was made clear in the Special Commissioner’sreport that James Hardie had no legal obligation to make up for theshortfall of funds in MRCF, the company was pressured to do so due toa sliding share price (as a result of community outrage and forecastsregarding the company’s future), the implementation of governmentbans on the purchase of James Hardie products, as well as the threat ofspecific legislation being introduced to in effect unwind the company’s2001 restructure so that liability could be imposed on the parentcompany. Accordingly, over thirteen weeks following CommissionerJackson handing down his report, James Hardie entered intonegotiations with the New South Wales Government and the AustralianCouncil of Trade Unions (‘ACTU’) to find a mutually satisfying way toresolve the impending funding crisis. The willingness of James Hardieto agree to negotiations was significant, given that the predominantreason for its move to The Netherlands in 2001 was to avoid having tofund the asbestos claims.

On 21 December 2004, an agreement between James Hardie, the ACTUand the New South Wales Government was announced. The agreement

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Research and Compensation Foundation’, (2004), [1.4].8 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the Medical

Research and Compensation Foundation’, (2004), [1.1.4].9 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the Medical


detailed the way in which James Hardie would compensate asbestosvictims for at least 40 years. James Hardie agreed to make annualpayments to a special purpose fund, capped at 35 per cent of its freecash flow. Initially, James Hardie agreed to inject into the specialpurpose fund three years worth of funding (approximately A$240million).10 The value of the agreement was estimated to be as high asA$4.5 billion.11

While the decision by James Hardie to negotiate a settlement obviouslywas designed with shareholder interests in mind, with the agreementseen as a way to improve the company’s economic and share priceperformance (indeed, on the day of the announcement the company’sshare price rose by six per cent and a number of boycotts on JamesHardie products were lifted), and it was in effect the lesser of two evils(the other option being specific legislation), commentators alsoemphasised that there was a moral element to the agreement.

One commentator described the James Hardie episode as ‘One ofAustralia’s most protracted and bitter fights for moral justice ended [by]James Hardie Industries signing the nation’s largest compensationsettlement, worth up to A$4.5 billion.’12 Indeed, James Hardie CEOMeredith Hellicar described the agreement as a ‘compassionate’outcome. Another commentator stated:

This year’s Special Commission found there was ‘no fundamental legalimpediment’ to what Hardie did before it moved offshore; divorce itselffrom subsidiaries that had manufactured building products and brakelinings containing the deadly fibre.

Hardie therefore gets some credit for negotiating a new funding deal andnot relying on the letter of the law to try to avoid its moral responsibility.Only some, however, because it had next to no choice.13

James Hardie’s agreement with the NSW Government and the ACTU wascertainly historic, and provides some degree of comfort for asbestosvictims. However, the agreement does not put to rest the need forlegislative intention to deal with similar scenarios to James Hardie whichmay arise in the future. This was recognised by prominent corporate lawexperts (including Professor Jennifer Hill and Professor Ian Ramsay) at apanel discussion on James Hardie held at Sydney Law School in February


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Research and Compensation Foundation’, (2004), [1.23].10 See Anthony Marx, ‘Accord Fires Up Hardie’, The Australian, (Sydney) 22 December

2004. 11 See ‘James Hardie Signs Compo Deal’, The Australian, (Sydney), 21 December 2004. 12 See Roz Alderton, Bianca Wordley and Kaaren Morrissey, ‘Hardie Agrees to $4.5bn

Payout’, The Age, (Melbourne) 22 December 2004.13 Malcolm Maiden, ‘Cost of Asbestos Exposure Does Not End Here’, The Age,

(Melbourne) 22 December 2004. 14 See Fiona Buffini, ‘Call to Widen Company Liability’, The Australian Financial


2005 as part of the annual Corporate Law Teachers Conference.14

Indeed, it is submitted that legislative intervention in relation to theJames Hardie controversy itself is still warranted to back up theagreement that has been reached. Also to provide even further certaintyand comfort for victims by covering any ‘gaps’ that may surface over timein the agreement, and to ‘strike while the iron is hot’ in legislating toprotect victims once the term of the historic agreement comes to an end.

IV RESTRICTING THE PRINCIPLE OF LIMITED LIABILITY:LAW REFORM MOVEMENT IN AUSTRALIA IN RESPONSE

TO THE JAMES HARDIE CONTROVERSY

In this section, I discuss how restricting the application of limitedliability to holding companies in relation to tortious claims againstsubsidiary companies was the major call for corporate law reform inAustralia in response to the James Hardie controversy. I then exploresome of the problems with approaching law reform in this way. Beforeengaging in this analysis, however, I first provide a brief explanation oflimited liability, including a discussion why I consider the limitedliability principle to be a fundamentally important shareholder right.

A Explanation of Limited Liability

In a recent article published in the Yale Law Journal, David A Skeel Jr,explained that limited liability means ‘that the shareholders of acorporation generally do not have any liability beyond the capital theyhave contributed to the corporation in return for their shares’, and thatlimited liability is ‘the attribute most people associate with the corporateform.’15

Further, in his report into James Hardie’s restructuring, CommissionerJackson explained that:

The principle of limited liability, that shareholders of a limited liabilitycompany are not personally liable, as shareholders for the debts of thatcompany, except to the extent of any unpaid capital on their shares, wasoriginally introduced by the Limited Liability Act 1855, which was soonreplaced and incorporated into the Joint Stock Company Act 1856.16

In Australia, the limited liability principle is given practical effect unders 516 of the Corporations Act, as part of the provisions regulating thewinding up of a company. Section 516 provides that:

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Review, (insert place of publication) 9 February 2005. 15 See David A Skeel Jr, ‘Corporate Anatomy Lessons’ (2004) 113 Yale Law Journal

1519, 1525.16 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the Medical


Subject to s 518 and s 519, if the company is a company limited by shares, amember need note contribute more than the amount (if any) unpaid on theshares in respect of which the member is liable as a present or past member.

Limited liability is a consequence of the separate entity principleestablished in the much cited House of Lords decision of Salomon vSalomon & Co Ltd,17 that a company is a legal entity separate from itsmembers. Limited liability and the separate entity principle are oftenconsidered to be interchangeable concepts, but this is not technicallycorrect.18 The two concepts are given practical effect through twoseparate parts of the Act.19 The operation of exceptions to the separateentity principle (operating to ‘lift’ the corporate veil) do not necessarilyunwind the limited liability principle.20

What I wish to emphasise at this point is that rather than limited liabilitybeing purely a commercial device, it also operates as an important


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Research and Compensation Foundation’, (2004), [1.51]. 17 [1897] AC 22, (‘Saloman’).18 See Annexure T to the D F Jackson QC, ‘Report of the Special Commission of Inquiry

Into the Medical Research and Compensation Foundation’, (2004), ‘The Concept ofLimited Liability – Existing Law and Rationale’, where Counsel Assisting theCommission explains that:

The separate entity doctrine is not only a fundamental legal principle but acommercial expectation entrenched within commercial investment practice.Coupled with limited liability it stimulates investment. The revenue from suchinvestment allows further research and development.

See also H A J Ford, R P Austin and I M Ramsay, Ford’s Principles of CorporationsLaw (11th ed, Sydney: Butterworths 2003), [4.160], where a good point is made as towhy separate entity doctrine and limited liability cannot be consideredinterchangeable concepts:

The separate entity doctrine does not itself import limited liability. It is stillpossible for a company to be registered as an unlimited company. But mostcompanies are companies limited by shares in which each shareholder’s liabilityis limited under the Corporations Act ss 514-529 to the amount they, or earlierholders of their shares, agreed to pay for the company for the issue of theirshares.

19 The principle of limited liability is given practical effect by s 516 of the CorporationsAct 2001 (Cth), under the winding up provisions of the Act, whereas the separateentity doctrine is given practical effect under s 124(1) of the Act, which provides thecompany with the capacity and powers of an individual and the powers of a bodycorporate, and s 119 which provides that, on registration, the company comes intoexistence as a body corporate.

20 See Susan Watson, ‘Who Hides Behind the Corporate Veil? Finding a Way out of “TheLegal Quagmire”’ (2002) 20 Company and Securities Law Journal 198, 201:

[What] was the significance of Salomon? The first major point is that it did not infact establish that shareholders have limited liability since the battle for limitedliability had been won some 40 years earlier [in 1855 under the Limited LiabilityAct] … In short, the case sets out the principle that a company is at law separatefrom its subsidiaries/members.’

See also at 206 highlighting that there is a distinction between the two concepts: Of course, [the case of Williams v Natural Life Health Foods [1998] 1 WLR830] … is not (or should not be) a reference to limited liability. It is a referenceto the fact that the director in carrying out the acts is separate at law from the


shareholder right, given that limited liability generates a number ofprivileges for shareholders. It is rarely the case that corporate law textsand commentaries label limited liability as a shareholder right, howeverthe direction of corporate law and governance is shifting to give greaterrecognition to shareholder rights, and limited liability is beginning to beexpressly recognised as a shareholder right. For example, in theOrganisation for Economic Co-operation and Development’s (‘OECD’)revised Principles of Corporate Governance21 released in April 2004,when discussing shareholder rights, limited liability is given centrestage:

Equity investors have certain property rights. For example, an equityshare in a publicly traded company can be bought, sold or transferred. Anequity share also entitles the investor to participate in the profits of thecorporation, with liability limited to the amount of the investment.22

Accordingly, with limited liability expressly and impliedly recognised asan important right which corporate law operates to provideshareholders, it is reasonable to expect that limited liability will beupheld and protected given the present ‘shareholder rightsmovement’.23 Indeed, I will discuss below that limited liability shouldonly be restricted if there is a fundamental justification for doing so.

The economic advantages associated with the operation of limitedliability, raised by law and economics commentators, further emphasisethe importance of limited liability as a privilege providing certain rightsand benefits for shareholders. The most commonly cited work outliningthe importance of limited liability to shareholders from an economicperspective is Easterbrook and Fischel, The Economic Structure ofCorporate Law, who cite the following advantages with limitedliability:

• Limited liability reduces the need of shareholders to monitor theiragents, such as directors and employees of the corporation;

• Limited liability also reduces the cost of monitoring other shareholders;

• Limited liability provides an incentive to managers to act in anefficient manner by promoting the free transfer of shares;

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company.21 OECD Principles of Corporate Governance (revised ed, Pariscedex: OECD 2004).22 OECD Principles of Corporate Governance (revised ed, Pariscedex: OECD 2004) 32.

This publication is available on-line at:<http://www.oecd.org/dataoecd/32/18/31557724.pdf>

23 For a discussion of the elevated place of shareholder rights shareholder participationin contemporary corporate governance, see Jean Du Plessis, James McConvill andMirko Bagaric, Principles of Contemporary Corporate Governance (Sydney:Cambridge University Press 2005) Ch 14.

24 See Frank H Easterbrook and Daniel R Fischel, The Economic Structure of Corporate


• It is said that limited liability also allows for more efficientdiversification by having a portfolio of investments in a number ofcompanies; and finally,

• Limited liability is seen as facilitating optimal investment decisionsthrough the diversification of investment in a number of differentcorporate entities.24

B Limited Liability and Corporate Groups

There is no precise statutory definition of ‘group’ in the CorporationsAct, however in High Court of Australia’s decision in Walker vWimborne,25, Mason J said:

The word ‘group’ is generally applied to a number of companies whichare associated by common or interlocking shareholdings, allied to unifiedcontrol or capacity to control assets and liabilities and meeting claims.26

Thus, in the context of corporate law, even in relation to corporategroups, each company remains a separate legal entity at law.

The James Hardie controversy is an important recent example of the useof separate companies to avoid certain liabilities through the protectionof the corporate veil for each company forming part of a group. Whilethe MRCF was established with a view to being completely separatefrom the James Hardie Group, a discussion of corporate groups is stillrelevant as:

• The companies responsible for the asbestos claims were groupcompanies when they negligently used dangerous asbestos materialsin their building and manufacturing ventures;

• The usual situation is that the responsible subsidiary companies willstill be part of the corporate group when the debts are incurred; and

• While MRCF is completely separate from the James Hardie Group,James Hardie has some control over MRCF’s operations in the sensethat it can inject further funds where necessary to ensure the entity’scontinued solvency.

Under a strict application of the Salomon principle, the reality of a


37

Law (2nd ed London: Harvard: University Press 1996) 47-48, cited in Roman Tomasic,Jane Jackson and Robin Woellner, Corporations Law: Principles, Policy and Process(4th ed, Sydney: The Federation Press 2002) 141.

25 (1976) 3 ACLR 52926 Walker v Wimborne (1976) 3 ACLR 529, 532.27 As stated in the report of the Companies and Securities Advisory Committee

Corporate Groups Final Report (2000), [1.48],In Australia, the corporate veil has been lifted if the corporate form has been usedimproperly, or if one company is the agent, trustee or partner of anothercompany. However, control or domination of a subsidiary by a parent, or otherforms of close economic integration within a corporate group, has not sufficed to


corporate group is not recognised, instead each company is recognisedas a separate legal entity, and this can be taken advantage of by eachcompany within the group. The use of a group structure is not a basisfor ‘lifting’ the corporate veil to restrict the application of limitedliability.27

Indeed, one of the key reasons for setting up group structures, with anumber of different companies operating within the group, is to takeadvantage of limited liability. In his report, Commissioner Jacksonstated: ‘One of the rationales for a group structure is to lower the risk oflegal liability by confining high liability risks, including environmentaland consumer liability, to particular group companies, with a view toisolating the remaining group assets from this potential liability.’28

From my research, it is submitted that there are two main possibilitiesto approaching regulation of corporate groups: one way which respects

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justify disregarding the separate legal personality of each group company. 28 See D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the Medical

Research and Compensation Foundation’, (2004), [1.8]. See also Annexure T to theSpecial Commission of Inquiry’s report, where Counsel Assisting the Commissionnotes:

The separate legal entity principle does not of itself ‘impose’ limited liability.However, the formulation of the company as a separate entity capable ofacquiring obligations separate from its members makes it possible for themembers to derive the privilege of limited liability; limited in the sense thatrecourse by the company’s creditors is only to the company’s assets rather thanthe totality of the member’s personal assets. Applied to corporate groups, theprinciple means that they can determine the size and choose the limits of theirlegal responsibility by the relatively simple mechanism of making onecompany a member of another company or companies in the group. (at 415)(emphasis added).

29 See Companies and Securities Advisory Committee Corporate Groups Final Report(2000), [1.44]:

Each company in a corporate group is a separate legal entity with its own rightsand duties, even when controlled or wholly-or-partly owned by another companyand collectively engaged in the business of the group. This has variousconsequences including … the debts incurred by each company are debts of thatcompany, not of the controllers of that company or of the corporate groupcollectively. The assets of the group cannot be pooled to pay for these debts.

It is stated in the CASAC’s report on corporate groups that the separate entityapproach involves three inter-related principles, originally developed for singlecompanies, but subsequently applied to corporate groups, namely: (a) separate legalpersonality of each group company (corporate autonomy), (b) limited liability ofshareholders of each group company, and (c) director’s duties to the separate groupcompany.

30 The Companies and Securities Advisory Committee Corporate Groups Final Report(2000),, provide the following explanation of the ‘enterprise entity approach’ to theregulation of corporate groups:

This approach recognises and attaches considerable legal significance toeconomic integration within a corporate group. In its pure form, it treats thecorporate group as a unitary economic enterprise functioning to further theinterests of the group as a whole, or those of its dormant corporate body.’ Under


and upholds the principle of limited liability as an important consequenceof separate legal personality (the ‘separate entity approach’),29 and onewhich recognises the reality of the group structure, so that it cannot beabused (the ‘single enterprise approach’).30

In upholding and respecting the principle of limited liability, I prefer theseparate entity approach. However, I also believe there arecircumstances based purely on legal responsibility where some flexibilityin the operation of the separate entity approach is required and that willbe reflected in my approach to law reform outlined below.

1 Chorus for Reform post-James Hardie

What needs to be made clear is that the specific objective commonlyraised in response to the James Hardie controversy was to implementcorporate law reform so that holding companies (and not just JamesHardie) could be liable for subsidiary company debts arising from claimsbased on personal injury or death.

The main impetus for this specific call for law reform was a paper byCounsel Assisting the Special Commission of Inquiry examining theMRCF discussing limited liability and its rationale (forming Annexure Tto Commissioner Jackson’s report). In that paper, Counsel Assistingproposed that:

The Commission should recommend reform of the Corporations Act so asto restrict the application of the limited liability principle as regardsliability for damages for personal injury or death caused by a companythat is part of a corporate group, confining the benefit of limited liabilityto members of the ultimate holding company.31

Interestingly, in an Australian Parliamentary Library note commentingon this recommendation to restrict limited liability, it was explainedthat:

If applied to the James Hardie case, this would mean the personal assetsof JHI NV members would still be protected, but the company’s assetswould be available to asbestos compensation claimants.32

In the Australian Labor Party’s (‘ALP’) corporate governance policypackage, released on 30 September 2004 in time for the 2004 FederalElection, the party adopted Counsel Assisting’s recommendation for


39

this approach, assets of the group could be pooled so that the assets of the holdingcompany could be used to fund the liabilities of the subsidiary companies. [1.59].

31 Annexure T to the D F Jackson QC, ‘Report of the Special Commission of Inquiry Intothe Medical Research and Compensation Foundation’, (2004), [27].

32 See Peter Price, Jerome Davidson and Susan Dudley, ‘In the Shadow of the CorporateVeil: James Hardie and Asbestos Compensation’, Australian Parliamentary LibraryResearch Note No. 12, (2004-2005).


reform of limited liability. While the ALP subsequently lost the election,it is useful to restate the ALP’s campaign position on reforming limitedliability:

At a Federal level, an incoming Labor Government is committed to lawreform and will consider all of the options for reform including CounselAssisting’s recommendation for reform of the Corporations Act so as torestrict the application of the limited liability principle, in respect ofclaims for damages for personal injury or death, to members of theultimate holding company.33

In his report released on 21 September 2004, Commissioner Jackson didnot have any specific position in relation to reforming limited liabilitybut did make the following comment in relation to Counsel Assisting’srecommendation:

The most wide-ranging reform suggested would have imposed limits onthe operation of the doctrine of limited liability. In a detailed submission,Counsel Assisting recommended reform of the Corporations Act so as torestrict the application of the limited liability principle, in respect ofclaims for damages for personal injury or death, to members of theultimate holding company.34

[T]he proposed reform is limited in that it does not seek to removelimited liability from all shareholders, only from parent companies. Itwould, therefore, have no impact on the liability of individual investors(whether corporations or natural persons), and should not impact ontheir willingness to pool their investment capital by resort toincorporation.35

Instead, Commissioner Jackson supported the introduction of astatutory scheme to guarantee that asbestos victims would becompensated According to Jackson:

The best long-term solution for satisfying the asbestos liabilities ofAmaca, Amaba and ABN 60 would be a scheme, for which that proposedby JH NV might be a starting point.36

B Issues Regarding the General Chorus for Reform

In my view, a law reform initiative restricting limited liability, even if itis confined to the application of limited liability in the context ofholding companies, is unwarranted. It is submitted that the sameoutcome, in terms of shifting liability to holding companies for certaindebts of subsidiaries where the subsidiary is not in a position to be able

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33 Australian Labor Party, ‘Labor’s Approach to Corporate Governance and FinancialServices: Creating a Culture of Accountability’, 30 September 2004, 17.

34 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004,), [30.69].

35 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004, [30.72].


to pay, could be achieved without specifically reforming limited liability.‘Restricting limited liability’ so that holding companies can be liable forthe debts of a subsidiary, while not imposing liability on individualshareholders, creates the (negative) impression that the privilege oflimited liability can be modified or even abolished in particularcircumstances. In order to protect the interests of other companystakeholders (in the case of James Hardie, asbestos victims i.e. creditors)that is the interests of other stakeholders are deemed to take precedenceover the interests of the company’s shareholders. At a time whenshareholder participation and the protection of shareholder rights aresuch important objectives in corporate law and governance, restrictingthe application of limited liability should be approached with extremecaution.

Furthermore, there is also a question as to how precisely ‘restrictinglimited liability’ to make holding companies liable would be achieved,and also, just as importantly, when restricting the application of limitedliability would be justifiable. In other words, lifting the protectionsoffered by the corporate law to holding companies seems like areasonable and appropriate initiative in the context of asbestos victimsmissing out on compensation, however more generally such anapproach to reform lacks detail and therefore legitimacy. There are anumber of questions which remain unanswered.

For example, would holding companies be automatically liable forsubsidiary debts, or would some responsibility for the incurring of debtsfirst need to be established? Further, would there need to be someknowledge or involvement on the part of the holding company? Wouldthe holding company be potentially liable for all debts of the subsidiarycompanies, or more specifically debts arising from personal injury ordeath? If so, what is the rationale for this? Would liability only arisewhen there is a shortfall in the funds of the subsidiary available tocompensate victims, or otherwise?

Given that there are important economic and rights-based justificationsfor the continued operation of the limited liability principle, it isextremely important to determine the scope of what is being proposed.While it is desirable to protect the rights and interests of asbestosvictims who may otherwise miss out on compensation, it is alsoimportant to recognise that limited liability is itself a right bestowedupon shareholders as a consequence of investing their funds into aparticular company.

V RESPONDING TO THE JAMES HARDIE CONTROVERSY: AMODERATE PROPOSAL FOR LAW REFORM

A Preliminary Points


41


At the outset, it is important to re-emphasise that with this article, I amnot intending to raise every possible avenue for reform to imposeliability on holding companies for subsidiary company debts, but onespecific reform proposal. There have been numerous potential reformsraised to deal with how liability could be imposed on a holding companyin a corporate group for the debts of its subsidiaries. In particularreforms of the voluntary administration and winding up rules under theCorporations Act, as well as changes to the principles of negligence ingroup arrangements, however I leave these reforms to be explored byother commentators.37

Further, I have tried to construct this reform proposal specifically inresponse to the factual scenario involved in the James Hardiecontroversy, as not only does this give the proposal some contemporaryrelevance, but also provides law reformers with a model which couldactually be implemented to deal with the shortfall of funds in the MRCFby imposing liability on James Hardie’s parent company, as the companymost responsible for the problems which have transpired.

B Section 588V-W of the Corporations Act

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36 D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004, [1.38].

37 The author refers the reader to the panoply of reforms contained in the Companiesand Securities Advisory Committee Corporate Groups Final Report (2000).

38 An excellent summary of the general operation of s 588V, and the defences under s588X, is provided in the Companies and Securities Advisory Committee CorporateGroups Final Report (2000) See [6.11]:

Under s 588V of the Corporations Act, a holding company contravenes theCorporations Act if:• It was the holding company of a subsidiary at a time the latter incurred a debt;• That debt caused, or was incurred during, the insolvency of the subsidiarycompany; and

• There were reasonable grounds to suspect that the subsidiary company was theninsolvent or would become insolvent by incurring that debt (or debts including thatdebt) and either

• The holding company or any of its directors was aware of the reasonable groundsfor suspecting the subsidiary’s insolvency; or

• Having regard to the nature of the holding company’s control over the subsidiaries,it was reasonable to expect that a company in the circumstances of the holdingcompany, or any of its directors, should be aware of these grounds for suspicion.

And in terms of possible defences under s 588X, it is noted by the Companies andSecurities Advisory Committee Corporate Groups Final Report (2000) [6.13] that theholding company has various defences including:• Where at the time when the debt was incurred the company or its directors:• Reasonably expected that the subsidiary was solvent (taking into account therelevant debt and any other concurrent debt);

• Reasonably believed that a competent and reliable person was responsible forinforming the holding company of the solvency of the subsidiary and that person


As has already been discussed, my proposal involves implementing anumber of important reforms to s 588X-W of the Corporations Act(which comprise Part 5.7B, Division 5 of the Act, entitled ‘Liability ofHolding Company for Insolvent Trading by Subsidiary’).38 To appreciatethe proposed reforms which I outline below, it is useful to reproduce s588V-W here.

588V When holding company liable

(1) A corporation contravenes this section if:(a) the corporation is the holding company of a company at the time when the

company incurs a debt; and(b) the company is insolvent at that time, or becomes insolvent by incurring

that debt, or by incurring at that time debts including that debt; and(c) at that time, there are reasonable grounds for suspecting that the company

is insolvent, or would so become insolvent, as the case may be; and(d) one or both of the following subparagraphs applies:

(i) the corporation, or one or more of its directors, is or are aware at thattime that there are such grounds for so suspecting;

(ii) having regard to the nature and extent of the corporation’s controlover the company’s affairs and to any other relevant circumstances, itis reasonable to expect that:(A) a holding company in the corporation’s circumstances would be

so aware; or(B) one or more of such a holding company’s directors would be so

aware; and(e) that time is at or after the commencement of this Act.

(2) A corporation that contravenes this section is not guilty of an offence.

588W Recovery of compensation for loss resulting from insolventtrading

(1) Where:(a) a corporation has contravened section 588V in relation to the incurring of

a debt by a company; and(b) the person to whom the debt is owed has suffered loss or damage in

relation to the debt because of the company’s insolvency; and(c) the debt was wholly or partly unsecured when the loss or damage was

suffered; and(d) the company is being wound up;the company’s liquidator may recover from the corporation, as a debt due to thecompany, an amount equal to the amount of the loss or damage.

(2) Proceedings under this section may only be begun within 6 years after thebeginning of the winding up.

588X Defences

(1) This section has effect for the purposes of proceedings under section 588W.

(2) It is a defence if it is proved that, at the time when the debt was incurred, thecorporation, and each relevant director (if any), had reasonable grounds to expect,and did expect, that the company was solvent at that time and would remainsolvent even if it incurred that debt and any other debts that it incurred at that time.


43


(3) Without limiting the generality of subsection (2), it is a defence if it is provedthat, at the time when the debt was incurred, the corporation, and each relevantdirector (if any):(a) had reasonable grounds to believe, and did believe:

(i) that a competent and reliable person was responsible for providing tothe corporation adequate information about whether the companywas solvent; and

(ii) that the person was fulfilling that responsibility; and(b) expected, on the basis of the information provided to the corporation by

the person, that the company was solvent at that time and would remainsolvent even if it incurred that debt and any other debts that it incurred atthat time.

(4) If it is proved that, because of illness or for some other good reason, a particularrelevant director did not take part in the management of the corporation at thetime when the company incurred the debt, the fact that the director was awareas mentioned in subparagraph 588V(1)(d)(i) is to be disregarded.

(5) It is a defence if it is proved that the corporation took all reasonable steps toprevent the company from incurring the debt.

(6) In subsections (2), (3) and (4):

relevant director means a director of the corporation who was aware asmentioned in subparagraph 588V(1)(d)(i).

An important point regarding s 588V, is that under s 588V(1)(d) you canhave regard to the nature and extent of the corporation’s control overthe company’s affairs and to any other relevant circumstances indetermining whether the holding company should be held liable. Thus,it does not actually (necessarily) need to be established that the holdingcompany, or any of its directors, were actually aware of the subsidiarycompany’s insolvency. In an article published in the ConnecticutJournal of International Law, Professor Ian Ramsay explains that theobjective of the main provision, s 588V, is to ‘make a holding companyliable for the debts of an insolvent subsidiary where the holdingcompany was aware or should have been aware of the insolvency.’39

Importantly, the report of the Companies and Securities AdvisoryCommittee (‘CASAC’) on corporate groups published in 2000 notedsome limitations with ss 588V, and 588X which would need to beaddressed if a law reform proposal was to be carried into effect. Themain limitations suggested by the CASAC in its report are that theprovisions:

• Rely upon the legal definition of holding/subsidiary companies.Business activities that pose higher than usual risk of failure can beorganised to avoid the creation of that relationship;

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was fulfilling that responsibility; or• Had taken all reasonable steps to prevent insolvent trading by the subsidiary.

39 See Ian Ramsay, ‘Allocating Liability in Corporate Groups: An Australian Perspective’(1999) 13 Connecticut Journal of International Law 329, 368.


• May require an express and expensive investigation of thecompany’s financial situation at the time of incurring specific debtsto determine whether it was then insolvent (although I believe thatthis problem would be minimised in relation to tortious claims if theultimate debt is incurred after winding up of the companycommences or the company enters into voluntary administration, asthe company would clearly be insolvent at the relevant time).

• Do not cover any debts incurred by a subsidiary whilst solvent, butwhich remain unpaid, and for which there are insufficient funds,after the insolvency.40

C Overview of the Reform Proposal: Amending s 588V/W ofthe Corporations Act

As is discussed in more detail later in this section, I believe that limitedliability as a privilege belonging to shareholders should be protected andcorporate law should not unduly interfere or restrict the ability ofcompanies to structure their arrangements to take advantage of the variousbenefits (tax, financing et cetera) that group structures provide, simply asa reaction to claims of a particularly vulnerable group in the community.

In weighing up the benefits of limited liability with the public policyconsiderations of ensuring that companies can be held liable if victimswould otherwise not have an avenue to pursue their rights, I believe that aspecific reform initiative should be implemented to impose liability oncontrolling entities for such debts only when a controlled entity is not in aposition to pay the debt. The controlling entity can be held partiallyresponsible through its control over the subsidiary, not for the personalinjury or death per se, but for the controlled entity incurring the debt (theclaim for damages) when it is not in a position to pay. It is important tomake clear that the problem, arising from James Hardie, which is nowsought to be addressed is not the actual incurring of tortious damages forpersonal injury or death due to the negligence of the subsidiary companiesper se, as unfortunate as this is. It is rather the inability of the subsidiarycompany to actually fund the debt once it arises and working out a waythat liability can be imposed on the holding company within the group.

Under my proposal, s 588V will be amended so that a ‘controlling entity’(rather than a holding company, a distinction explored further below)will potentially be liable for any debts arising from tortious claimsagainst a subsidiary company. The most important aspect of myproposed reform is to expressly define ‘incurring a debt’ so that itincludes involuntary debts incurred through tortious (or indeedcriminal) claims. I will explain below why the meaning of ‘debt’ for thepurposes of this provision is presently not considered to encapsulatedamages arising from compensation for torts. There will be an expressdefinition of ‘incurring a debt’ for the purposes of s 588V to include


45


incurring tortious damages from personal injury or death (not alltortious claims) which invokes a positive duty based on public policy.

If it can be satisfied on the evidence that the controlling entity or itsdirectors at that time had reasonable grounds to suspect that thecontrolled entity would not be able to pay the debt once it was‘incurred’ (which could be satisfied with reasonable certainty in JamesHardie given the actuarial reports which have been prepared over timeto indicate that there would be a shortfall in funds to compensatevictims), then it would again be reasonable for liability to be imposed onthe controlling entity. This is due strictly to the control it exerted overthe controlled entity and hence its ability to do something so that thesubsidiary companies and the victims of the company’s negligencewould not be placed in such an undesirable position.

My specific reform proposal is not in fact a new idea, othercommentators have in the past pointed out that s 588V does not applyto tortious damages incurred by a subsidiary, and that the section couldprovide an avenue for extending the liability of holding companies inparticular circumstances to tortious claims against subsidiarycompanies.41 However, as far as I can tell, this is the first time that aproposed new s 588V has actually been drafted and explained. It is alsothe first time in which some of the potential difficulties and issuesrelating to a such a reform have been explored and addressed, so thatwe can be confident that the faith placed in a revised s 588V toadequately fulfil the present objective in corporate law is deserved.

Furthermore, given the potential for this reform proposal to actually beadopted to impose liability on James Hardie if it does not honour itsagreement with the NSW Government and the ACTU (or after theagreement transpires), I deal with the special nature of asbestos-relateddiseases and how a revised s 588V could actually be drafted to directlyaccommodate the unique position of asbestos diseases which may notsurface until many years after the claimant came into contact with theasbestos, and the difficulties that may accordingly arise in the holdingcompany being held liable in this situation. I also deal with the specificsituation in relation to James Hardie, in which asbestos liabilities havebeen assigned to an entity which is completely separated from thecorporate group so that it cannot be described as a subsidiary company.

The construction of a statutory corporate law provision to allow forliability for asbestos-related diseases (and similar ‘latent’ diseases) to bedirected to the holding company, but in a way which is not designed to

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40 See Companies and Securities Advisory Committee Corporate Groups Final Report(2000), [6.28].

41 See Ian Ramsay, `Holding Company Liability for the Debts of an Insolvent Subsidiary:


directly undermine the limited liability principle, has been a task whichrequired considerable thought and reflection. My solution as to how s588V could specifically deal with asbestos-related claims which ariseyears after the subsidiary company has been wound up, is unique andwill be presented and explained in detail below.

D Constructing a Reform Proposal

1 Considerations Arising from James Hardie

Responding to the problems arising with James Hardie needs to be donein a way that continues to respect the important commercial benefitswhich derive from companies having this freedom to structure theiraffairs, but recognises that there are circumstances in which thisfreedom can be abused. This potential for abuse has been described asthe ‘capital boundary problem’.42

2 Details of the Proposal

To begin with, what follows is how s 588V-W of the Corporations Actwould look if my proposed reforms were implemented, followed by adetailed explanation of some of the key components of my reformproposal, including discussion of the rationale behind each keycomponent. I will also briefly analyse the strengths and weaknesses ofthe proposal, but await a response from other commentators.

If my proposed reforms are implemented, s 588V-W would read asfollows:

588V When controlling entity liable

(1) A corporation contravenes this section if:(a) the corporation is a controlling entity of a company at the time when the

company incurs the debt, or is the controlling entity of a company whichcaused the debt at the relevant time that the debt was caused; and

(b) the company which incurs the debt is insolvent at the time, or becomesinsolvent by incurring that debt, or by incurring at that time debts includingthat debt; and

(c) at that time, there are reasonable grounds for suspecting that the companywhich incurred the debt is insolvent, or would so become insolvent, as thecase may be; and

(d) one or both of the following subparagraphs applies:(i) the corporation, or one or more of its directors, is or are aware at that

time that there are such grounds for so suspecting;(ii) having regard to the nature and extent of the corporation’s control


47

A Law and Economics Perspective` (1994) 17 University of New South Wales LawJournal 546.

42 According to Hugh Collins, the capital boundary problem which arises consists ofthis: because the firm dictates its own size, it also chooses the limits of its legalresponsibility, which in turn provides an open invitation for the evasion of mandatory


over the affairs of the company which incurred the debt, or thecompany which caused the debt, and to any other relevantcircumstances, it is reasonable to expect that:(A) a company in the corporation’s circumstances would be so

aware; or(B) one or more of such a company’s directors would be so aware;

and(e) that time is at or after the commencement of this Act.

(2) A corporation that contravenes this section is not guilty of an offence.

(3) For the purposes of this section, in determining whether a corporation is acontrolling entity of a company, refer to the definition of control in s 50AA ofthe Act.

(4) For the purposes of this section, incurring a debt includes a liquidated amountof damages against the company which is determined by a court, tribunal orregulatory body, and a criminal fine.

588W Recovery of compensation for loss resulting from insolventtrading

(1) Where:(a) a corporation has contravened section 588V in relation to the incurring of

a debt by a company; and(b) the person to whom the debt is owed has suffered loss or damage in

relation to the debt because of the company’s insolvency; and(c) the debt was wholly or partly unsecured when the loss or damage was

suffered; and(d) the company is being wound up;the company’s liquidator may recover from the corporation, as a debt due to thecompany, an amount equal to the amount of the loss or damage.

[Deletion of six-year time limitation for bringing claims under subsection(2)]

588X Defences

(1) This section has effect for the purposes of proceedings under section 588W.

(2) It is a defence if it is proved that, at the time when the debt was incurred, thecorporation, and each relevant director (if any), had reasonable grounds to expect,and did expect, that the company was solvent at that time and would remainsolvent even if it incurred that debt and any other debts that it incurred at that time.

(3) Without limiting the generality of subsection (2), it is a defence if it is provedthat, at the time when the debt was incurred, the corporation, and each relevantdirector (if any):(a) had reasonable grounds to believe, and did believe:

(i) that a competent and reliable person was responsible for providing tothe corporation adequate information about whether the companywas solvent; and

(ii) that the person was fulfilling that responsibility; and(b) expected, on the basis of the information provided to the corporation by the

person, that the company was solvent at that time and would remain solventeven if it incurred that debt and any other debts that it incurred at that time.

(4) If it is proved that, because of illness or for some other good reason, a particularrelevant director did not take part in the management of the corporation at thetime when the company incurred the debt, the fact that the director was aware

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as mentioned in subparagraph 588V(1)(d)(i) is to be disregarded.

(5) It is a defence if it is proved that the corporation took all reasonable steps toprevent the company from incurring the debt.

(6) In subsections (2), (3) and (4):relevant director means a director of the corporation who was aware as mentionedin subparagraph 588V(1)(d)(i).

(a) ‘Incurring’ a Debt

(i) General

The phrase ‘incurring a debt’, which is used in s 588V, is not actuallydefined in the Act, however it is generally considered that by ‘incurring’being associated with ‘debt’, the phrase probably does not encompassdamages arising from tortious claims (or indeed criminal fines).However, this is in relation to s 588G which contains a positive dutyupon company directors to prevent insolvent trading, it may not in factbe relevant to s 588V which does not contain such a positive duty.

According to one of Australia’s leading texts on corporation law, Ford’sPrinciples of Corporations Law, the word ‘incur’ by itself does notappear to be limited to voluntary debts – based on the dictionarydefinition of the word (from the New Shorter Oxford Dictionary), ‘incur’can mean running into or meeting with something or it can meanbringing something upon itself.43 Importantly, this would seem toaccommodate non-voluntary debts, however the word needs to beapplied consistency with the context in which it is used and statutorypurposes.44

In relation to s 588G, the context suggests against involuntary debtsincurred by way of tortious damages or criminal fines, however the


49

legal rules. See Hugh Collins, ‘Ascription of Legal Responsibility to Groups inComplex Patterns of Economic Integration’ (1990) 53 Modern Law Review 731, 736-737.

43 See H A J Ford, R P Austin and I M Ramsay, Ford’s Principles of Corporations Law(11th ed, Sydney: Butterworths 2003), 871:

s 588G … seems to use ‘incur’ in a sense requiring some act or omission of thecompany. The heading to Div 3 of Pt 5.7B, which is part of the Corporations Act,refers to ‘Director’s Duty to Prevent Insolvent Trading’. The actus reus in theoperative part … is failure to prevent the company from incurring the debt.

Precisely on point is the case of Geraldton Building Co. Pty. Ltd. v Woodmore (1992)8 ACSR 585, 590, in relation to the duty to prevent insolvent trading in s 588G, ratherthan s 588V- in that case Master Bredmeyer said: ‘A director is not liable for damages.Debts and damages are quite distinct. … Incurring a liability for damages does notconstitute the incurring of a debt for the purpose of s 592.’

44 See, eg, Hawkins v Bank of China (1992) 26 NSWLR 562 at 572; See also Antico(1995) 18 ACSR 1; Shepherd v ANZ Banking Group (1996) 20 ACSR 81.

45 Ian Ramsay, ‘Allocating Liability in Corporate Groups: An Australian Perspective’(1999) 13 Connecticut Journal of International Law 329


context may be considered different to s 588V. That said, the generalconsensus among commentators on s 588V, including one of Australia’sleading corporate law experts Professor Ian Ramsay, is that the meaningof ‘incurring a debt’ in relation to s 588V is similarly confined tovoluntarily incurred debts45 and therefore the present author proceeds onthis basis.

Under my proposal, in light of the James Hardie controversy, therewould be an express definition of ‘incurring a debt’, whereas currentlythere is not one, so that the concept includes involuntarily incurreddebts, such as tortious damages and criminal fines. The circumstances,which resulted in the recent Special Commission of Inquiry, can be saidto have arisen from the negligence of James Hardie’s subsidiaries.46

As has already been stated, the proposal to extend s 588V so that itcaptures debts incurred from tortious claims is not new. A number ofcommentators has suggested reform in the past, including Ian Ramsay.In an article published in the Connecticut Journal of InternationalLaw, Professor Ramsay based his suggestion for an extension of s 588Von a law and economics analysis of the provision. In that article,Professor Ramsay argued:

A tort claimant is the creditor least likely to be able to protect him orherself against the risk of harm by a company. There are a number ofreasons why this is so. First, unlike other creditors, a tort claimant orvictim is not in a contractual relationship with the company. Because ofthis, he or she cannot contract to be compensated for assuming the riskof injury, nor can the tort claimant contract around the rule of limitedliability the way other creditors do. Second, the tort claimant cannotassess the creditworthiness of the company before the tort occurs. Othercreditors do have this opportunity prior to entering into a contract. Third,the tort claimant will be an inefficient monitor of managers compared toother creditors. … The problem is particularly serious in the context ofcorporate groups. This is because a company can establish subsidiaries,each with minimal assets, for the purpose of conducting hazardousactivities that may result in tort claims. The purpose is to minimize theexposure of the assets of the corporate group to tort claims.47

(ii) At What Point Should the ‘Debt’ Be Deemed to be Incurred?

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46 In the D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004) [12.3], Commissioner Jackson saidthat:

[The asbestos liabilities] were based on tortious conduct of James Hardie Groupcompanies - usually negligence in the manufacture or distribution of asbestosproducts - which had occurred in 1987 or earlier.

47 See Ian Ramsay, `Holding Company Liability for the Debts of an Insolvent Subsidiary:A Law and Economics Perspective` (1994) 17 University of New South Wales LawJournal 546., 372-373; see also Annexure T to the D F Jackson QC, ‘Report of theSpecial Commission of Inquiry Into the Medical Research and CompensationFoundation’, (2004), 418.


There is no express definition of ‘debt’ in the Corporations Act,however commentary speaks of the need for there to be a ‘liquidatedamount’ before a debt can be incurred under the insolvent tradingprovisions. According to Ford’s Principles of Corporations Law, a debtis liquidated when its amount is fixed or can be calculated positively.48

Thus, even though the tortious act or omission by which the claimmaterialises may have occurred well beforehand, the debt would stillnot be incurred until the amount of a claim is determined by the relevantcourt or tribunal. This position derives support from the case ofShepherd v Australian and NZ Banking Group Ltd,49 in which BrysonJ rejected the argument that a debt which accrued later was in factincurred at the earlier stage when the contractual time for performancepassed, leaving it in control of the payer to make an election whichwould actually create a debt.

When we see that ‘debt’ has been defined in this way, there arepotential problems which emerge if the meaning of debt is to beextended to cover involuntarily-incurred amounts, namely tortiousdamages. If a debt is not ‘incurred’ until the amount of a claim isliquidated through determination of a court or by some other body,there is the potential for the parent company to place the subsidiarycompany under ‘voluntary administration’, or use its authority as thedominant shareholder in the subsidiary to voluntarily ‘wind up’ thecompany (I provide below an explanation of the law of voluntaryadministration and winding up in Australia). This approach could bepursued so that the subsidiary company is not capable of incurring thedebt, and the holding company can therefore avoid liability. As a result,the victim who is seeking compensation against the subsidiary companywould have no recourse to s 588V to obtain compensation. This isespecially a problem with ‘latent’ asbestos-related diseases, which mayarise many years after the company responsible for the debt has beenwound up. This problem was indeed raised by Commissioner Jacksonin his report:

…An injured plaintiff’s ability to sue for damages in respect of the injurywill not be effective if there is not a financially substantial defendantavailable and responsible for the damage. … A reflection of this is that intheory JHL might have caused the subsidiary to be put into liquidation, inwhich case future claimants, not having contracted an asbestos-relateddisease, or been exposed to asbestos, would have no one to recoveragainst once the company’s assets had been distributed.50

The main concern is whether it is a possibility for holding companies toorganise for the winding up of the subsidiary company in complete


51

48 H A J Ford, R P Austin and I M Ramsay, Ford’s Principles of Corporations Law (11thed, Sydney: Butterworth 2003) [20.090].


disregard of the impending claim of the victims to avoid the operationof s 588V in its proposed amended form. That is, would subjectingholding companies to potential liability lead to a so called ‘phoenix’company arrangement whereby the directors of a failed companytransfer all the assets to a newly-formed company to avoid liability.

While this is an important issue that does require attention, a review ofinsolvency law in Australia demonstrates that the concerns raised aboutthe potential reform are unfounded. Entering the company in voluntaryadministration, or commencing winding up of the company would notautomatically prevent liability being imposed on the ultimate holdingcompany, and it is unlikely that the subsidiary company could be woundup if there were impending claims for tortious damages arriving in thefuture.

I will deal first with voluntary administration, and then with winding up.

(iii) Voluntary Administration

Under Part 5.3A of the Corporations Act, if a company is insolvent ornearing insolvency, the directors of the company can pass a resolutioncausing for the company to appoint an administrator (an independentqualified person) to take control of the company, with the view to ensuringthat the company continues in existence.51 Usually the company’screditors will meet to approve a deed of company arrangement dictatinghow the administrator is to manage the affairs of the company.52

The important question, which arises in relation to voluntaryadministration, is whether a debt can be ‘incurred’ for the purposes of s588V once the subsidiary company has been placed under voluntaryadministration. This question arises because under the CorporationsAct, once a company enters into voluntary administration, there is ageneral suspension (or ‘moratorium’) on the rights of claimants againstthe company under administration, until the outcome of the creditor’s

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49 (1996) 20 ACSR 1.50 See D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the Medical

Research and Compensation Foundation’, (2004), [12.13]-[12.14]. 51 The objects of Part 5.3A are expressed in s 435A of the Corporations Act. The section

provides that:The object of this Part is to provide for the business, property and affairs of aninsolvent company to be administered in a way that:

• Maximises the chance of the company, or as much as possible of its business,continuing in existence; or

• If it is not possible for the company or its business to continue in existence- resultsin a better return for the company’s creditors and members than would result froman immediate winding up of the company.

52 For an explanation of the law of voluntary administration in Australia, see ColinAnderson and David Morrison, Corporate Voluntary Administration Law (3rd ed,


determination as to the company’s future.53 Section 440D of the Actprovides that no proceeding in a court against a company underadministration can be commenced by any person except with theadministrator’s consent or the leave of the court.

The purpose of this suspension or moratorium is to provide thesubsidiary company with some breathing space, ensuring that the fundsof the company are not dissipated through meeting new claims, and thatthe task of the appointed administrator is not made unnecessarilydifficult. Accordingly, I believe that this suspension places no barrier oninstituting proceedings against a holding company/controlling entityunder s 588V, if it is made clear that the reason for establishing thatthere is a debt is to take action against the holding company/controllingentity. Rather than, to directly target the subsidiary company andpotentially reduce the pool of assets available to the administrator.Under these circumstances, I am confident that in most, if not allcircumstances, either the administrator or the court would provide itsapproval for a debt to be pursued during administration.

It should also be said that the consequences of placing a company undervoluntary administration are different for s 588V compared to thedirector’s duty to prevent insolvent trading under s 588G. In relation tothe duty under s 588G, placing a company under voluntaryadministration can operate as a defence under s 588H(6) on the basisthat the director took all reasonable steps to appoint an administrator.Pursuant to this provision, if a director seeks to prove the defence, thecourt must consider any action the director took with a view toappointing an administrator, the time when that action was taken andthe results of that action. Appointment of an administrator wouldprovide no defence for a tortious claim against the subsidiary. As thenegligent act giving rise to the claim would have arisen prior to thecompany actually entering into voluntary administration, that is theadministration can play no role in preventing the debt being occurred,so why should it actually operate as a defence?

(iv) Voluntary Winding Up

Rather than utilising the voluntary administration regime, another optionthat could be pursued by the holding company is to utilise its control asthe majority shareholder of the subsidiary to voluntarily wind up thecompany. There is a procedure for voluntary winding up by membersunder Part 5.5, Division 2 of the Corporations Act. Like with voluntary


53

Sydney: Thomson 2002). 53 See H A J Ford, R P Austin and I M Ramsay, Ford’s Principles of Corporations Law

(11th ed, Sydney: Butterworths 2003), [27.040].


administration, once a company commences winding up and aliquidator is appointed, there is a stay of proceedings against thecompany between the time of filing for winding up, and the order forwinding up.54

This would again protect the company from claims, unless the courtsgrant leave. However, while it is a possibility for the holding companyto utilise the voluntary administration regime once there is animpending claim(s) for tortious damage(s), as all that needs to beestablished is that the subsidiary company may become insolvent in thefuture, voluntary winding up by members would not be available underthese circumstances. This is because this form of winding up can onlybe used when the company is solvent, and when the company is surethat the company will be able to pay its debts in full within a period notexceeding 12 months after the commencement of the winding up.55

Obviously, if there are outstanding and impeding debts against thecompany based on claims of tortious damages against the companybeing successful, the company clearly could not satisfy this keyrequirement, and hence voluntary winding up would not be available.

There is a further avenue for the holding company, as the majorityshareholder in a subsidiary, to apply to the court under s 459A (inreliance on s 459P) for the winding up a company on the basis that it isinsolvent. However, it is unlikely that the company will actually beinsolvent (based on the definition of solvency in s 95A, that is the abilityto pay debts as and when they become due) before incurring the debtof a liquidated amount of damages, as it is the actual incurring of thedebt which usually renders the subsidiary company insolvent.Accordingly, this would not be a useful mechanism for the holdingcompany to avoid the application of s 588V.

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54 See s 471B of the Corporations Act.55 Section 494 establishes as a prerequisite to voluntary winding up that a majority of the

company’s directors provide a written declaration to the effect that they have madean inquiry into the affairs of the company, and that they have formed the opinion thatthe company will be able to pay its debts in full within a period not exceeding 12months after the commencement of the winding up. While the section use the word‘may’, case law has established that the declaration is a compulsory rather thandiscretionary requirement: Re Kyra Nominees Pty Ltd (1980) 5 ACLR 60. Accordingto Simon Fischer, Leanne Wiseman and Colin Anderson, Corporations Law (2nd ed,Sydney, Butterworths, 2001 [23.2.3]:

The object of the declaration of insolvency is to prevent a company from abusingthe voluntary winding up procedure where it is, in fact, insolvent.

Importantly, s 494(4) provides that it is an offence if a director makes such adeclaration without having reasonable grounds for believing that the company will beable to pay its debts in full. Section 494(5) provides that there is a presumption againstthe director having reasonable grounds if the debts are not paid in full within the


Therefore, it appears to be suitable to retain the existing position inAustralia that a liquidated amount needs to be determined before a debtis said to be ‘incurred’.

(b) Substituting Control Test for Holding Company/Subsidiary Test

At present, s 588V imposes liability on a ‘holding company’ of a‘subsidiary’ if the subsidiary incurs a debt while insolvent. A ‘subsidiary’company is defined under the Corporations Act, s 46:

A body corporate is a subsidiary of another body corporate if, and only if:(a) the other body:

(i) controls the composition of the first body’s board;56 or(ii) is in a position to cast, or control the casting of, more than one-half of

the maximum number of votes that might be cast at a general meetingof the first body; and

(iii) holds more than one-half of the issued share capital of the first body.

What can be seen with the definition of subsidiary is that it isfundamentally based on the level of shareholding, or voting power inrelation to shares, that one company has in relation to another company.Thus, imposing liability on a holding company directly attacks andundermines the operation of the limited liability principle. Due to thisrather strict, narrow definition of subsidiary in the Act, there have beenproposals in the past (both generally in relation to the Corporations Actas a whole, and more specifically in relation to s 588V) for the holdingcompany/subsidiary test to be changed to a control test. In most cases,it has been suggested that the present definition of ‘control’ under s50AA could provide the basis for the general control test.

‘Control’ is defined in s 50AA in terms which extend to practicalinfluence and which take account of practices and patterns ofbehaviour, rather than just embodying a strict de jure test for control,which applies in relation to the subsidiary/holding company test.57

Section 50AA(1) states that for the purposes of the Corporations Act, anentity controls a second entity if the first entity has the capacity todetermine the outcome of decisions about the second entity’s financialand operating policies. Subsection (2) goes on to provide that indetermining whether the first entity has this capacity;

1 the practical influence the first entity can exert (rather than the rightsit can enforce) is the issue to be considered; and

2 any practice or pattern of behaviour affecting the second entity’sfinancial or operating policies is to be taken into account (even if it


55

period stated in the declaration.56 See s 47 of the Corporations Act, for an explanation of what is meant by controlling

the composition of the first body’s board. 57 See H A J Ford, R P Austin and I M Ramsay, Ford’s Principles of Corporations Law


involves a breach of an agreement or a breach of trust).

In its report on corporate groups released in 2000, the Companies andSecurities Advisory Committee of the Australian Parliament suggestedthat the substitution of a control test for the holding/subsidiary test waspreferable. It was considered that the control test would be much moreflexible and of much wider scope. Accordingly, the CASACrecommended that the

… control test is preferable to the holding/subsidiary and relatedcompany tests. The former test may better identify all forms of de factocontrol, as it is not limited to control through majority shareholding orcontrol through composition of the board of directors. The control testshould apply in all circumstances.58

Professor Ramsay has also proposed that in relation to s 588V, theapplication of the holding company/subsidiary test is not entirelydesirable. In his article published in the Connecticut Journal ofInternational Law,59 when discussing s 588V, it was explained thatthere are problems associated with using the definition of subsidiary,which would not arise if a broader and more flexible definition of‘control’ were used. According to Ramsay, as there is a strict and rathernarrow definition of subsidiary under s 46 of the Act, companies canavoid liability under s 588V by adjusting their shareholding or level ofvoting control so that the relationship is not one of holding company/subsidiary. Such specific avoidance of the operation of s 588V wouldnot however be possible if the more flexible test of control, based onpractical influence rather than strictly levels of shareholding or votingpower, is adopted. As Ramsay states, ‘It is now possible to see why s588V presents obvious strategies for evasion.’60

Due to the holding company/subsidiary test directly undermining thelimited liability principle by imposing liability strictly for holding sharesor having voting power in relation to shares, rather than more broadlyattaching liability based on control, and the difficulties associated withusing the holding company/subsidiary test, my proposed reformsabandon the holding company/subsidiary test for the control test.Liability would be imposed on a ‘controlling entity’ of a ‘controlledentity’ with the meaning of control for this purpose based on thedefinition of ‘control’ under s 50AA of the Act. However, when lookingspecifically at the facts involved with James Hardie, this change wouldnot adequately respond to the particular situation in that case of thesubsidiary companies responsible for the asbestos-related diseases being

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(11th ed, Sydney: Butterworths 2003), [23.080].58 Ian Ramsay, ‘Allocating Liability in Corporate Groups: An Australian Perspective’

(1999) 13 Connecticut Journal of International Law 329, [1.39].59 Ian Ramsay, ‘Allocating Liability in Corporate Groups: An Australian Perspective’


separated from the Group prior to the claims for tortious damages beingdetermined. Under this situation, liability could not be imposed on theJames Hardie Group under s 588V, as it would no longer be thecontrolling entity when the debt is actually incurred (at the time ofliquidation).

Indeed, this situation may not be limited to James Hardie. If a holdingcompany could escape liability under s 588V by ensuring that thecompany is separated from the corporate group before the debt isincurred, then this would present a major gap in the operation of s 588Vand undermine the effectiveness of the provision. Accordingly, in orderto directly respond to the factual scenario relating to James Hardie, andto overcome the potential for a major gap in the law to develop, it isproposed that s 588V would also attach liability to a company that wasa controlling entity at the time when the debt was caused (i.e. thenegligent act occurred). Also the company, which has assumed thatdebt becomes insolvent when the debt is incurred, or is alreadyinsolvent when the debt is incurred, and none of the defences under s588X are available to the controlling entity.

(c) Change to Heading of Part 5.7B, Division 5

Part 5.7B, Division 5 of the Corporations Act, which encompasses s588V-X of the Act, is currently headed ‘Liability of Holding Company forInsolvent Trading by Subsidiary’. This would no longer, however,adequately reflect the contents and rationale of the provisions under thisPart if my proposed reforms were implemented. As part of my reforms,it is therefore proposed that the heading of Part 5.7B, Division 5 bechanged to ‘Liability of Controlling Entity for Insolvent Trading ofControlled Entity.’

E Critical Analysis of the Proposal

What follows is a brief analysis of the strengths and weaknesses of myproposal. However, the author invites other commentators to furthercritique the effectiveness of the proposal in responding to the JamesHardie asbestos affair, and the specific problems arising from the JamesHardie controversy of imposing liability on holding companies for certaindebts incurred by subsidiaries when the subsidiary is unable to pay.

1 Key Benefits of the Author’s Proposal

In my view, the proposed reform package is a sophisticated and effectiveresponse to the specific problems arising out of the James Hardiecontroversy, and involves very moderate reform – rather than unwieldyreform based ‘restricting the principle of limited liability’, which wouldunduly undermine the rights of shareholders.


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The primary benefit of my proposal is that liability will only attach if onthe facts it can be said that an entity which has control over another entity(according to the definition of ‘control’ under the Act) has takenresponsibility for the second entity not being able to pay a debt which isincurred resulting from a successful tortious claim for personal injury ordeath. While obviously the controlling entity will usually be a holdingcompany of a subsidiary based on having a substantial shareholding in thecompany, and hence such a reform would affect the operation of limitedliability, it is important to understand that this would be an indirect effectrather than a direct attack on the limited liability principle. The impact onlimited liability would be in an indirect manner, in the process of assigningresponsibility based on control, rather than in a direct manner.

Importantly, from a symbolic level at least, the proposal protects andupholds the rights of shareholders in general terms as under theproposal, rather than imposing liability on the holding company on thebasis that they are a major shareholder in the company (and thusrestricting the application of the principle of limited liability) the reformproposal would sheet home liability to the holding company on thebasis that it is a controlling entity vis-à-vis the subsidiary entity, with thiscontrol not necessarily deriving from being a major shareholder in thecompany. In this sense, my proposal does not seek to directlyundermine the principle of limited liability. Rather it provides a verylimited situation where companies within a group arrangement will notbe treated strictly as separate entities at law.

2 Responding to Potential Weaknesses in the Proposal

One potential criticism of my proposal is that it may be unduly harsh onholding companies. However the obvious response is to emphasise thatthe proposal would not make holding companies (or what would be‘controlling entities’) liable unless they knew or should have known thatthe subsidiary was insolvent or would become insolvent by incurringthe debt. It needs to be made clear that the basis for liability would bethat there is some clear responsibility upon the controlling entity.

Furthermore, on this point it is important to emphasise that the reformswould not be too indeterminate or uncertain, as once there is a validclaim presented, the holding company can actually raise one or moredefences under s 588V (such as that there were reasonable grounds toexpect solvency, or that the relevant company took reasonable steps toprevent incurring the debt). Thus, if those defences are not available onthe facts to protect the controlling entity, then it is reasonable that it besubjected to liability.

Another issue that relates to the last point is why in fact liability is being

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imposed on the controlling entity – clearly the controlled entity doesnot have sufficient assets to pay the debt, but is this any reason toimpose liability on a separate legal entity at law? Is there anything thatthe holding company/controlling entity could have done?

In my view, the responsibility comes from ‘control’ – control over thefinancial and operational affairs of the company. In exercising controlover the company, there are a number of things that the controllingentity could do to prevent the problem of victims being left out ofpocket. A consequence of exerting such control, is a duty to ensure thatthe company would not continue to operate whilst insolvent. But wouldnot this injection of capital by the holding company be in breach of thedirectors of the holding company’s duty to act in the best interests ofthat particular company, rather than the group as a whole? In otherwords, is it reasonable, and consistent with public policy, that thedirectors need to breach their fiduciary duties, and face potentialpersonal liability, in order to avoid the holding company /controllingentity being liable for the debts of the subsidiary company under s 588V?

While the general position is that directors of a particular company mustact in the best interests of that company, rather than the group forwhich the company forms a part, there are circumstances in whichassisting another group company may be consistent with their fiduciaryduties to the first company. This was made clear by Mason J in the HighCourt of Australia decision of Walker v Wimborne,61 and there has beensupport for this view in a number of subsequent decisions.62

In the context of the James Hardie controversy, it is certainly clear, ashighlighted in Commissioner Jackson’s report, that it would have inbeen in the best interests of James Hardie’s parent company to havemade extra funds available to the MRCF to place it in a better positionto compensate asbestos victims, and to prevent the later public scandalwhich transpired and damaged the reputation of the James Hardie


59

(1999) 13 Connecticut Journal of International Law 329.60 Ian Ramsay, ‘Allocating Liability in Corporate Groups: An Australian Perspective’

(1999) 13 Connecticut Journal of International Law 329, 375.61 (1976) 137 CLR 1. In that case, Mason J said (at 6-7) that:

… [The] payment of money by company A to company B to enable company B tocarry on its business may have derivative benefits for company A as a shareholderin company B if that company is enabled to trade profitably or realize its assets toadvantage.

62 See, eg, Equiticorp Financial Services Ltd v Bank of New Zealand (1993) 11 ACSR642.

63 See D F Jackson QC, ‘Report of the Special Commission of Inquiry Into the MedicalResearch and Compensation Foundation’, (2004) [12.23], in which CommissionerJackson suggested that as a practical matter James Hardie’s parent company should


Group.63 Accordingly, it is appropriate that responsibility be assigned(and indeed extended under my proposal) to the holdingcompany/controlling entity under s 588V.

VI CONCLUSION

It was pointed out in the introduction that the main issue arising from theJames Hardie controversy is how and when to make holding companiesliable for tortious damages resulting from personal injury or death, andfor which the subsidiary company is responsible. It was explained thatthe recent focus for proposed corporate law reform in Australia has beenon restricting the operation of the limited liability principle, so that itdoes not apply to holding companies when a subsidiary company isunable to meet claims for personal injury or death.

I have responded to this call for reform in this article, with what Ibelieve to be a moderate, and effective, proposal which is consistentwith the recent focus for reform, but in a way which is not designed todirectly undermine the principle of limited liability. Rather, myproposal seeks to impose liability according to whether a controllingentity bears some responsibility for the specific problem highlightedwith James Hardie. The specific problem being that a subsidiarycompany is incurring debts, involuntarily incurred, but is unable to pay.As a legislative response to James Hardie potentially draws closer tobeing realised, I hope that the merit in this reform proposal isrecognised, and that the proposal is adopted in the Corporations Act todeal with similar such problems which may arise in the future.

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Documents

REVISITING HOLDING COMPANY LIABILITY FOR SUBSIDIARY